Where was the outrage in 2007?

One reason I like Matt Yglesias’s blog is because he is much less “tribal” than most other bloggers of the left and the right.  Here he takes a shot at liberals who insist it’s obvious that we need more government spending during the current recession, but somehow forgot to call for less government spending during the preceding boom:

Or at the state and local level, anyone who’s thinking seriously about the issue ought to see that the middle of a recession is a terrible time to implement major cutbacks in public spending. But at the same time, people who believe in good faith that state and local spending is above the optimal level will understandably agree with Rahm Emannuel that you don’t want to let a good crisis go to waste. After all, were center-left Keynesian economics bloggers issuing table-thumping condemnations of state and local spending increases in 2004-2007? Bemoaning the fact that we’d entered a new “dark age” of macroeconomic understanding where policymakers didn’t realize that under the circumstances states and municipalities ought to be trimming its workforce and accumulating huge surpluses? I think I missed that.

Like Yglesias, I don’t particularly care whether people on my side are offended by my opinions.  So I’ll keep attacking my friends and allies on the right whenever I don’t agree with their views on monetary policy.

Update 12/4/10:  When I woke up this morning I realized the preceding paragraph is all wrong.  It suggests I’m more courageous than other bloggers, which is both incorrect and kind of insulting.  My apologies.]

Here’s a question that puzzles me.  We know the right is up in arms over the Fed’s recent move toward monetary stimulus.  Yes, inflation is only 1.2% and core inflation is only 0.6%.  And yes, unemployment is 9.8% and rising.  But despite these dreary numbers it is viewed as an outrage that the Fed is trying to boost the growth rate of aggregate demand to a more normal level.

So this got me wondering about the right’s reaction to the Fed’s policy of easing during 2007.  As you may recall, the Fed cut rates several times during 2007.   I checked and found that the inflation rate during 2007 was 4.1%, more than double the Fed’s target.  Unemployment was below 5%.   So if the right was angry about monetary easing when inflation is half the Fed’s target and unemployment is double the natural rate, they must have been absolutely apoplectic about Fed easing when inflation was more than double the Fed’s target, and unemployment was below the natural rate.  After all we’re constantly being told that the Fed’s job is to produce price stability.  Period.  End of story.

Now I can imagine some apologist for the right arguing that the Fed needed to cut interest rates in 2007 because there was a banking crisis.  But haven’t we been told over and over again that the Fed should focus on targeting inflation, that it has no business targeting other variables?  So clearly that can’t be the explanation.

So what is the explanation?  Maybe there were a lot of complaints back in 2007 and I have just forgotten.  Were conservatives complaining that monetary stimulus would merely bail out the failed Bush administration fiscal policies, and allow him to put off the tax increases necessary to balance the budget?  I don’t recall reading that argument, but perhaps I forgot.

I’m not good at searching out old editorials; perhaps some commenters can help me.  But here is the Fed press release from the September 2007 rate cut:

Release Date: September 18, 2007

For immediate release

The Federal Open Market Committee decided today to lower its target for the federal funds rate 50 basis points to 4-3/4 percent.

Economic growth was moderate during the first half of the year, but the tightening of credit conditions has the potential to intensify the housing correction and to restrain economic growth more generally.  Today’s action is intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time.

Readings on core inflation have improved modestly this year.  However, the Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully.

Developments in financial markets since the Committee’s last regular meeting have increased the uncertainty surrounding the economic outlook.  The Committee will continue to assess the effects of these and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Charles L. Evans; Thomas M. Hoenig; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; William Poole; Eric Rosengren; and Kevin M. Warsh.

Not one vote against?  Thomas Hoenig could have voted against any rate cut.  He could have supported a quarter point rate cut and voted against the half point cut.  But he decided to vote for the full 50 basis point cut, which was more than markets expected and which set the stock market soaring.  And he did this at a time when unemployment was 4.7% and inflation was running at double the Fed’s target.  Interesting.

Another possibility is that conservatives think that right now money is really easy because the base has ballooned and rates are near zero.  Of course the same was true during the 1930s.  Come to think of it, conservatives also thought money was really easy during the 1930s, indeed they thought it was too easy.  Later Friedman and Schwartz showed conservatives how tragically mistaken they had been.  But perhaps they forgot.



19 Responses to “Where was the outrage in 2007?”

  1. Gravatar of Nick Rowe Nick Rowe
    3. December 2010 at 20:52

    Good point.

    It makes me think there might be something to the (Paul Krugman’s?) “pain caucus” idea. Some conservatives are saying “We have sinned. We must punish ourselves with tight monetary policy.”

  2. Gravatar of david david
    3. December 2010 at 23:17

    I seem to recall table-thumping condemnations of tax cuts, but Bush did those in 2001 and 2003. Here was Krugman in 2001.

  3. Gravatar of Richard W Richard W
    4. December 2010 at 02:49

    I am not surprised that you like the Matt Yglesias blog Prof. Sumner as he usually copies whatever you write about. Although he does have interesting things to say of his own. I agree with Prof. Rowe that there is a “pain caucus” out there and it is not unique to the US. Much of the sheer incompetence by the ECB for the last two years has been driven by a warped sense of morality. The subtext is that there are the virtuous and the sinners and the sinners must be punished. It is an almost quasi-religious view that sees monetary policy as a medieval morality play. The fact that the alleged virtuous and sinners are two sides of the same coin is totally lost on those who see monetary policy in moral terms. You are quite right to point out the absurdity of supporting monetary easing when unemployment was lower and inflation higher and being opposed when they are reversed.

  4. Gravatar of David Tomlin David Tomlin
    4. December 2010 at 05:54

    What I remember/understand, is that after Volcker/Reagan monetary policy vanquished stagflation, conservatives thought it expedient to give all the credit to ‘supply side’ tax cuts. From then until the recent QE2 debate, conservatives and liberals agreed that macroeconomics was all about fiscal policy. Monetary policy might be mentioned by a pundit now and then, but for the must part it was ignored in mainstream political discourse.

    To test this, I suggest finding some transcripts of candidate debates and searching for words and phrases like ‘Federal Reserve’, ‘money’ and ‘monetary’. I did this once for the Bush/Gore and Bush/Kerry debates, and found essentially nothing.

  5. Gravatar of Anton Tonev Anton Tonev
    4. December 2010 at 06:18

    If only they had printed money every single time we got in a recession, instead of cutting interest rates, we would most likely never have ended in the present situation of so much debt. Isn’t there a very deep conflict between two of the (three) attributes of money, i.e. between money as a “means of exchange” and money as a “store of value”? A conflict that eventually causes a breakdown in the current monetary system?
    Money is an essential variable in the equation of economic growth. I am not so interested in the mathematical formulation of the above (whether it be Fisher’s M.V=P.T, or Cobb-Douglas’ Y=F(A.K.L )), I am more interested in the conceptual framework where money “drives” economic growth. There is a profound misunderstanding of money and its use in society. It must be pretty obvious to everyone with common sense that money is needed if our society is expected to function normally for we use money as a means of exchange. At the same time, we use money as a store of value – we do save for a rainy day! And herein lies the conflict, if we are expected to progress we need more money as we engage in more transactions, but at the same time, doesn’t the creation of more money cause money to gradually lose its value? And, so, it is obvious that for much of human history (the human history that coincides with the introduction of money as in notes and coins – fiat money) and especially in recent economic history, there is a resistance to printing money – and that is true not just in normal times but also and especially so in recessions. I maybe be exaggerating but I am not too far from saying that lack of money causes recessions. There is some kind of irrational fear factor associated with it – that something that is so powerful can be created at no cost – surely there must be something fishy, mysterious about it? Is it this fear that stops central bankers from printing money when the economy drops in a recession?
    There are those people that will point out to the fact the USD has lost over 90% of its purchasing power since the Fed was created and conclude that this institution has been hugely irresponsible. They are not necessarily wrong as they view money from a store of value concept. But at the same time, the Fed needs to print money to maintain the normal functioning of the economy and to maintain a constant rate of growth – money as a means of exchange is like the oil in the engine – we need money for progress! And how much has global GDP increased since the 1900s? The US has hardly printed enough USD to allow for the normal functioning of the (global) economy. Given that USD is the world’s reserve currency, cash (notes in circulation in USD) as a % of global GDP is at just 1.5%. Will it be a stretch of the imagination to state that the lack of US Dollars was the cause of the huge pile-up of debt in the world and the subsequent creation of the shadow banking system? How else could we continue to grow? Thanks to the invention of the fractional banking system, we managed to create fictional dollars, for the lack of real ones, and that’s what kept us afloat. And now everyone, from serious economists to random people on the net are raging against it when in reality we did not have a choice…We needed money to grow, the money was not there, but the banks created it as part of the frictional reserve system in the terms of credits.
    We have clearly hit the proverbial ceiling on the use of US dollars globally as a means of exchange exactly because 1)more US dollars reduces its store of value; 2) we have been “caught red handed” trying to create too many fictional US dollars. Even though maybe half (my estimate) of China’s reserves are not real (but borrowed), still China uses the US dollar as a store of value. And so do pretty much all other central banks in the world. But not the populace (even though the super rich across the world do to some extent – they have however, been diversifying away in real estate, gold, art, etc. – the things that the central banks of the world cannot do). And that is the “eternal” conflict of interest. In that sense, it will be so incredibly important for the Eurozone to continue to exist, or rather for the EURO to continue to exist as it allows for an alternative means of exchange, it takes so much pressure off the US dollar. And that is why it is so important for the Chinese currency to be free to float – as it also eventually will offer another means of exchange. I guess, if we are smart enough to see the “value” of money as means of exchange before we self destruct ourselves economically, we will have a monetary system similar to the 18-19 centuries dual silver/gold standard whereby we will have 2-3 different means of exchange. But ultimately, this system will also have its time. Until we somehow manage to separate the “means of exchange” concept from the “store of value” concept we will always have recessions…

  6. Gravatar of Doug Bates Doug Bates
    4. December 2010 at 06:21

    Tribal is a good word for it. I think our modern Internet-driven political tribes are more loyal to their tribal interests than to the national interest.

    As much as I’d like for my liberal tribe to succeed, I think fiscal policy was expanded as much as was prudent — so I must disagree with Krugman’s endless drumbeat that we need more fiscal stimulus. The increased federal deficit was/is just big enough to offset the private sector’s decreasing leverage.

    But for the conservative tribe to be picking on monetary stimulus right now makes no sense, unless they want the economy to continue failing so a Republican will win in 2012. Core inflation is the lowest recorded, and unemployment is too high and not improving. So more monetary stimulus is, as they say, a no brainer.

  7. Gravatar of JTapp JTapp
    4. December 2010 at 06:30

    Scott, in fairness the Austrian-leaners on the right were upset at the Fed in 2007. See those “Peter Schiff was right” YouTube videos where he contends with others on the right (Art Laffer, Ben Stein, etc.) who were cheering the Fed on.

    I’m thankful that David Beckworth (who was also critical of the Fed) took the right to task in his recent NRO online article outlining the conservative case for QE2. The crass reaction of Mark Calabria (which Beckworth responds to) is typical: (paraphrase) “You’re just a Keynesian.”

  8. Gravatar of JTapp JTapp
    4. December 2010 at 06:33

    “Another possibility is that conservatives think that right now money is really easy because the base has ballooned and rates are near zero.”
    Calabria (link above) and plenty other “supply-side” conservative bloggers are arguing that money demand is not high and has not been for some time.

  9. Gravatar of David Pearson David Pearson
    4. December 2010 at 07:53

    The Fed was acting to stem a generalized, systemic bank run starting as early as August of 2007:


    By the time there is a run on the banking system, it is too late to argue for “conservative sound money”. So the Fed’s role is to make sure liquidity crises do not occur in the first place. Conservatives should have been outraged over the Fed’s asymmetric Fed policy that led to the 2007 liquidity crisis; but alas, most conservatives were too busy trumpeting the “Bush Boom” to bother.

    In contrast to 2007, today there is no threat to the functioning of the credit channel, and no liquidity crisis. What conservatives should take issue is the Fed’s embarking on a new round of asymmetric policy. Sure, one can make the case for looser policy today; but only if one believes the Fed would tighten if needed. “If needed” does not mean, “as real growth spikes”; it means, “if inflation expectations rise above 3% even while unemployment remains above 8%.” Responding by saying, “That can’t happen,” is the same thing as accepting policy asymmetry in the event that it does.

  10. Gravatar of scott sumner scott sumner
    4. December 2010 at 08:42

    Everyone, When I reread my post I thought the tone was all wrong in one place, and added an update.

    Nick, Thanks. I did a post in early 2009 on the Puritan instinct in American monetary policy (and German?)

    David, I anticipate that’s how Krugman would reply to Yglesias. Of course he now insists that spending changes are much more powerful than tax changes (in terms of effects on AD.) So the spending response should be symmetrical. Or else he might argue that we weren’t in a liquidity trap before 2007. So he would have several possible excuses. Still, you could argue that state governments should balance their budget over the long term. Since people like Krugman insist “we all knew” 2006 was a bubble, the state of California should have socked away all the tax revenue from 2006 and used it when the bubble burst. But of course they didn’t.

    Richard, Those are good points about the ECB.

    David, I agree that monetary policy wasn’t very controversial during the Great Moderation, but I do think many conservatives agreed that Volcker had helped bring inflation down. I think the Mundellian argument was that tight money and supply side tax cuts in combination could bring inflation down while also promoting real growth.

    Anton, I agree that tight money is often a cause of recessions, but that also means that money is usually too easy during booms. I don’t think many people would say the AVERAGE rate of inflation has been too low since 1913.

    Doug, I agree.

    JTapp, Yes, I like that Beckworth article. I don’t doubt that Austrians thought money was too easy, but mainstream conservatives (Congressmen, famous conservative economists and pundits, etc) seemed much quieter than today.

    Calabria is wrong about money demand not being high, indeed it’s not even debatable. We have good data on both real and nominal money demand, and it certainly is high.

    David Pearson, So you’re claiming that when the conservatives insist that the Fed should focus on stabilizing the price level and nothing else, what they really mean is that they should focus solely on the price level unless they need to bail out the banking system. But there is no need to bail out the 17 million unemployed, after all most of their banker chums don’t personally know any unemployed people. No “crisis” in the labor markets.

    The Fed is being bashed by the public for being too easy at a time when unemployment is 9.8% and inflation is 1%. Are we to believe the public will suddenly start bashing the Fed for being too tight if inflation rises above 3%? I don’t think so. Actually, one to two years of 3% inflation would be fine, to make up for the undershoot. But I don’t see it happening (at least for core inflation.)

  11. Gravatar of Anton Tonev Anton Tonev
    4. December 2010 at 13:24

    I was trying to make a clear distinction between money as in notes and coins and money as in credit. The overall money supply (including credit) has been going up more or less in line with GDP growth and you are absolutely right that perhaps in the good times money was too loose and in recessions money was too tight. But the increase in the money supply over the last 30 years at least has been mostly due to the increase in credit, while notes and coins has barely increased and therein lies our problem. I have managed to get a hold of some data on notes and coins in circulation in different countries and have compared this to the country’s GDP. In Japan, the ratio (notes and coins to national GDP) was around 30% from 1980s till 1994 and then has been steadily been rising to currently around 65%. In Switzerland, it was around 40% between 1980s and 1990s then went to around 30% until 2009 when it jumped to almost 90%! In the UK, the ratio has declined from around 20% in 1980s to about 12% in 2000s and since then it has risen back to about 16%. For the Eurozone, the ratio has steadily risen from around 20% in 1997 to about 35% now (excluding a dip in 2001 to about 13%). Obviously not much data is available for the Eurozone. Finally, in the US, this ratio has been declining from around 12% in 1947 to about 4% in 1992 and since then it has gradually increased to about 6%. Notes and coins, being the narrowest possible of money supply, is pretty meaningless in a fractional reserves system and more so in a credit-based society. But is it? Isn’t that the foundation of the fractional reserve system? And if the foundation is not sound how can the system survive? If we do try to deleverage as we are doing just now and if we keep the cash in circulation constant, it does not matter how much fiscal stimulus we pump in the economy, we will not grow. But also, let’s assume that I am wasting my time at looking at this data, however, I still want to understand why is this ratio in the USA so much out of whack with the rest of the developed world? Is it because of the fact that US Dollar is the reserve currency of the world? But if that is the case isn’t it logical that there must be even MORE US Dollars in circulation to satisfy the demand for them throughout the world? Surely, it has something to do with the fact that the Anglo-Saxon world is a credit-card based society. But nevertheless, Is there an optimal ratio that central bankers should try to adhere to? Is that ratio maybe 30% (all of the above countries had that ratio about there before something happened that they increased it – Japan, Switzerland, or they decreased it – UK, while Europe has been steady around it all the time). Is there a tipping point whereby below it the country is supposed to “suffer” a prolonged period of disinflation and low growth and above (another level much higher) it is expected to suffer hyperinflation? What was that ratio in Germany during its experience of hyperinflation in the 1920s? From a pure conceptual point of view, isn’t it possible that the situation right now in the world is similar to the period of the Great Depression also in terms of global monetary policy? In other words the “Golden Fetters” (Barry Eichenberg) of today is the lack of enough supply of US Dollars in the world. There was no way to increase the supply of gold then apart from alchemy – and that was proven to be futile. So, we rightly got off the gold standard for the sake of progress and human evolution. Should we get off the US Dollar standard? Or print more dollars? Getting off the dollar standard is unthinkable right now, but printing money…We can do that, why are we not doing it?

  12. Gravatar of Rod Everson Rod Everson
    4. December 2010 at 16:37


    You can’t print more “notes and coins,” i.e., currency, in the sense of getting people to carry more of it (currency) because currency is voluntarily carried by people and businesses. If you print too much, it will just end up in the Fed’s vaults as banks take in the excess from customers and either use it as reserves or send it back to the Fed. Either way, you can’t force currency to circulate. You can, however, force people to carry more deposits, simply by expanding reserves (under normal circumstance, not the case today.)

    This was actually the problem with using the Fed’s monetary base as a leading indicator in the 50’s, 60’s and 70’s. People decide to carry increased currency only after prices have risen. They are used to carrying, say, $100, but as prices rise the $100 runs out earlier and earlier and finally they start carrying a larger amount. Thus, currency, a major component of the monetary base, is actually a lagging indicator of monetary policy, not a leading one.

    When I removed currency from the monetary base, leaving what I then called (in 1976 or so) “Effective Reserves,” I found that effective reserves was a much, much better forecaster of the effects of Fed policy since WWII than was the monetary base. (All this became much more obscured with the introduction of NOW accounts in 1980 or so.)

    This entire experience convinced me to follow reserves much more closely. They are what normally determines whether the Fed is being easy or tight. Now, with interest being paid on reserves, even that measure has been compromised. Frankly, I doubt that anyone can tell you whether the Fed is being easy or tight right now. Even the Fed doesn’t know where their current policy is actually leading. It’s just a lot of guesswork centered on how the various QE’s are going to ultimately pan out.

  13. Gravatar of Rod Everson Rod Everson
    4. December 2010 at 17:00

    Doug Bates, you wrote: “So more monetary stimulus is, as they say, a no brainer.”

    And how, precisely, would you define “monetary stimulus” Doug, since we need “more” of it. What should we look at to see that we’re getting more exactly.

  14. Gravatar of ShawnT ShawnT
    4. December 2010 at 18:59

    Scott, just wondering if you can comment on this article by John Cochrane at U of C: http://faculty.chicagobooth.edu/john.cochrane/research/papers/QEII.html

    I know that you say that money and tbonds are not the same thing but what about his argument that QE could lead to stagflation and a Greek style crisis?

  15. Gravatar of david david
    4. December 2010 at 19:33

    Krugman’s been railing against California’s Prop 13 (restricting how taxes are raised), too. So he’s covered his bases there.

  16. Gravatar of scott sumner scott sumner
    5. December 2010 at 06:24

    Anton, Your data on currency demand in foreign countries seems way too high to me. Last time I looked it was more in the 2% to 10% range, as a share of GDP. You might want to double check.

    I agree that currency and coins are important, the bedrock of our monetary system. But you can’t simply compare them to credit. Even you admit they are rising as a share of GDP.

    I agree that we need more dollars, or else less dollar demand (lower IOR)

    Rod, You said;

    “You can’t print more “notes and coins,” i.e., currency, in the sense of getting people to carry more of it (currency) because currency is voluntarily carried by people and businesses. If you print too much, it will just end up in the Fed’s vaults as banks take in the excess from customers and either use it as reserves or send it back to the Fed. Either way, you can’t force currency to circulate. You can, however, force people to carry more deposits, simply by expanding reserves (under normal circumstance, not the case today.)”

    I don’t agree. If the Fed simply does OMPs, and then puts a negative 4% interest rate on reserves, the money will circulate.

    ShawnT, I’ve actually addressed his argument many times. He is wrong in treating QE in a mechanistic way. The reason it has an effect is that it signals to the markets that the Fed has adopted a higher implicit inflation target. In addition, money and reserves are not perfect substitutes. And finally, we already know it works, because stocks, foreign exchange, and TIPS spreads all rose in reaction to the Fed rumors of QE. That alone discredits his argument.

    David, California is a relatively high tax state. They have a roughly 10% income tax. Lack of taxes is certainly not their problem.

  17. Gravatar of Rod Everson Rod Everson
    5. December 2010 at 08:10

    Scott, you wrote: “I don’t agree. If the Fed simply does OMPs, and then puts a negative 4% interest rate on reserves, the money will circulate.”

    Anton was talking about currency, not demand deposits. You cannot force the public to hold currency. They will hold exactly the amount they feel they need to carry out daily transactions (or hoard as drug money, or stick in the mattress because they don’t trust banks, etc.) You could print a trillion dollars of extra currency, but there is no mechanism by which to force the public to hold it, much less circulate it. Bank deposits, however, are an entirely different story. But Anton was talking specifically about currency, not deposits.

  18. Gravatar of Anton Tonev Anton Tonev
    6. December 2010 at 14:18

    The data on notes and coins is from Datastream. The point of printing more notes and coins is not that it will end up in the people’ pockets – I am far from advocating a return to a cash-only credit free society. It is about the confidence in the system as a whole – as long as these notes and coins end up in the bank’s vaults that is good enough. The fractional reserve system is stretched to the limit an that is the problem. We’ve gone from one extreme, several hundred years ago, when the banks ended up taking money from a saver and lending the money to a borrower to the system now when the banks simply create the money for the borrower-again this is not necessarily bad at all but when taken to the extreme it does raise issues for the sustainability of the banking system. So the (broad) money supply is increasing but the majority of the increase comes from the increase in credit.
    In that sense paper money has already been replaced in a sense by digital money. Nothing wrong with that – one might say digital money is the future, who knows – the problem is that depositors are not having any of that yet and there were a few situations when people were concerned with the safety of their actual savings in some banks to the extent that they were lining up wanting to withdraw them. Would it be an exaggeration to say that majority of money in our bank accounts is someone else’s debt and because of the current situation with paying back these debts we should rightly be concerned? Anyway, to get back the point I was trying to make is that printing more notes and coins will increase confidence in the banking system (at the expense of reducing confidence in the US dollar perhaps – eventually) and that is better than using QE whereby we create more debt – note I am not against QE as long as it is not sterilized – which it is as Bernanke mentioned in his 60 minute interview the other day. But even sterilized QE I guess is better than doing nothing.

  19. Gravatar of ssumner ssumner
    8. December 2010 at 18:29

    Rod, I know he was talking about currency. And I still say you can force the public to hold it. Indeed I think the most fundamental theorem in all of monetary economics is that the Fed can force the public to hold more nominal cash balances, but not more real cash balances. If the Fed doubles currency, and the public doesn’t want to hold it, they aren’t go to throw it in the trash. Instead the price level will double, and voila, the public will want to hold it.

    I still say the Datastream data is wrong, but someone else will have to do the work of checking it out. I did my dissertation on currency hoaridng, and have a pretty good sense of how much currency is held in different countries.

    Again, I have no objection to mor ecurrency, but I’m not sure I completely follow your argument.

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